Treatment of client money on firm’s administration

CASE = Yesterday, Mr Justice Briggs delivered his judgment in the matter of Lehman Brothers International (Europe) v CRC Credit Fund Ltd & Ors [2009] EWHC 3228 (Ch) on the identification and distribution of the client money held by Lehman Brothers International (Europe) (LBIE) at the time it was placed into administration.

ISSUES = This involved the interpretation of the FSA client money rules set out in Chapter 7 of the Client Assets Sourcebook (CASS). This proved particularly difficult for three main reasons: the extreme complexity of LBIE’s operations; the potential shortfall of over US$1billion in the client money held by LBIE due to the insolvency of its German affiliate Lehman Brothers Bankhaus AG; and, the “massive failure” by LBIE to identify and segregate all the client money it was holding.

SUMMARY – In outline the CASS rules provide for client money to be identified and promptly paid into client accounts, segregated from the firm’s house accounts. The firm holds this money on trust for the client. On the failure of a firm, the rules provide for client money to be pooled (into a Client Money Pool (CMP)) and distributed back to those that are entitled to it.

RULING =  (confirming many of the conclusions in Re Global Trader Europe Limited (in liquidation) No 1) as follows:

1.    The trust over client money takes effect from the moment client money is received by the firm and not from when it is segregated.

2.    The CMP consists only of client money in the firm’s segregated client accounts. Client money held in LBIE’s other accounts – for instance, money that it failed to segregate correctly – does not form part of the CMP.

3.    There is no justification under CASS or the general law for any shortfall in the CMP to be corrected by topping it up using client money held outside the CMP or from LBIE’s general estate. In effect, the judge found that the CASS rules set out how a firm ought to hold client money, but do not provide a mechanism for correcting non-compliance with those rules.

4.    A client’s share of the CMP is determined by the amount which LBIE actually segregated for that client and not how much it ought to have segregated. This means that clients whose money was not correctly segregated by LBIE will not be entitled to a distribution from the CMP.

5.    A client’s client money entitlement is calculated as at the date the CMP was constituted, i.e. on the administration of LBIE. Events that occur after that date – such as the fluctuation in exchange rates or the movement in open positions – are not to be taken into account when calculating the entitlement.

A copy of the judgment is available. http://www.bailii.org/ew/cases/EWHC/Ch/2009/3228.html